As published in Scotsman Guide's Commercial Edition, May 2008.
Bridge loans are short-term loans meant to give investors time to solve whatever problems are preventing them from qualifying for permanent financing or from selling their properties. The duration of these loans typically ranges from a few months to a few years.
Many investors are hesitant to use bridge loans because these loans often come with a higher price tag than permanent debt. What they're overlooking, however, is the economic benefit that comes from these loans' inherent flexibility.
Uses and benefits
In real estate investing, timing is everything. There are several reasons why borrowers may need to close on a property quickly. They may need to satisfy a 1031 exchange, prevent a foreclosure or bankruptcy, or take advantage of a fire sale. Unexpected delays during construction or lease-up also may mean they have to repay a construction loan, even though they can't qualify for permanent financing.
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One of the most-common uses for a bridge loan is to reposition an asset. There are two main benefits associated with this strategy.
First, it can allow borrowers to achieve higher leverage. This is because bridge lenders may be willing to underwrite to lower debt-service-coverage ratios (DSCRs). They do this when they believe that the borrowers' business plan will increase the revenue from the property and increase the DSCR in future years.
Second, bridge loans often have limited or no prepayment penalties. As such, investors can increase a property's cash flow quickly to refinance and receive permanent rates on their higher leverage amounts. Had these borrowers gotten permanent financing based on their original cash flows, they would now have to pay a significant prepayment penalty to recapitalize.
Developers looking for a bridge loan must create a detailed business plan showing the lender how they intend to lease up the property after the previous failure. They will also need to provide a good explanation for why the problem occurred in the first place.
The last thing that a bridge lender wants is to inherit the construction lender's problems. If the borrowers can address these issues, then the lender can usually step in and make the loan. This type of short-term loan ultimately lets developers complete their project and profit from their labor.
To get the full benefit from this type of lending, borrowers must be open about their plans for the property in question and about their general financial situation. Complete disclosure allows for maximum collaboration and creativity, which may be necessary to execute the investors' strategy successfully.
Bridge lenders usually have conservative leverage limitations. They also tend to be on the higher side of the cost-of-funds spectrum. Nevertheless, bridge loans can save borrowers a lot of money in the long run through deferred tax payments or getting an asset at a deep discount.
The best bridge lenders offer speed and flexibility to their borrowers. Many can close in as few as 10 days or even fewer, if the situation calls for it. They also offer creative solutions to borrowers needing additional proceeds. For example, they may accept additional collateral such as equity in another property, securities or an art collection.
Overall, bridge lenders' interests should be closely aligned with borrowers'. The last thing that most lenders want is to take back a property that is halfway through a repositioning or a lease-up.
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In many cases, a bridge loan makes the difference between profit and loss. If time is all your clients need to turn a bad situation into money, a bridge loan may just be their best option.
Joseph Cacciapaglia is director of investments for Llenrock Realty Partners, a direct bridge-debt-provider based in Philadelphia. Llenrock offers capital in the $3 million to $30 million range for commercial real estate owners and developers in the United States, Canada, Mexico and the Caribbean.
Visit www.llenrock.com for more information. Contact Cacciapaglia at email@example.com or (215) 483-1388.